Taxation and the law of diminishing returns

The current proposals of taxing charitable entities may pose more harm than good

Taxation and the law of diminishing returns

On a recent visit to Shorkot, a small town close to the city of Jhang, I met with a young female entrepreneur Umme Laila. She was only 20 years old and had been supporting her family along with her younger brother for the past year, as her father had passed away suddenly.

Unlike other young women in her community, Umme Laila is a fighter and despite resistance from her extended family she decided to take out a small loan of Rs20,000 from Kashf Foundation to start a fledgling stitching unit in her home. She decided to employ 3 other young women from her neighbourhood, and with the help of her brother she managed to obtain her first order to sew four dozen shirts. Since then she has not looked back.

When I asked her, if entities like Kashf were not able to lend to her at an affordable rate, what would have been her options? After a brief pause, Umme Laila replied that her family would have most likely starved, as they did not have any means to earn an income otherwise.

Umme Laila’s story is typical of the 4.8 million entrepreneurs who are supported through microfinance loans across the country. Many of such households stay afloat because of the small capital injections they get from time to time, that help to sustain their micro businesses. A recent impact assessment undertaken by Kashf has shown that microfinance beneficiaries have been able to increase monthly income by 33 per cent, which allows families to invest in the better nourishment and education of their children.

Women entrepreneurs belong to the undocumented economy and most of them, due to lack of financial credibility, would not be served by formal financial institutions. They are not even significant enough to be counted as part of the country’s GDP.

By and large, microfinance institutions provide this sector small to medium sized loans to help improve their quality of life and most important, help in alleviating poverty. In the case of Kashf, financial services are especially provided to women like Umme Laila to enhance their economic role and decision making capacity, while ongoing investments are undertaken to enhance their productivity and business returns. Like her peers, Umme Laila also developed a business plan with the help of Kashf foundation’s business development officer.

Women entrepreneurs like Umme Laila belong to the undocumented economy of Pakistan and most of them, due to lack of financial credibility, would not be served by formal financial institutions. In fact they are not even significant enough to be counted as part of the country’s gross domestic product. Their development and progress, however, is vital for a stable economy for not only is the informal sector providing jobs to millions, it is also a primary source of earning for thousands of poor families.

Furthermore, youth unemployment and under-employment are on the rise. With 1.5 million new job entrants in the job market annually, the economy has not been able to keep pace with growth rates at 3-4 per cent, and many of them have to create their own jobs. As mentioned, NPOs have played a significant role to create jobs for their critical segment.

According to a recent report issued by the World Bank, Pakistan’s tax deficit stands at Rs3.2 trillion annually. Trade deficit has widened, stock of debt is ballooning, rupee value has depreciated and while the current government talks about growth under their watch, the inequitable distribution of wealth and resources across the country is becoming stark.

In an effort to raise revenue and fill a hole in its budget, the current government is introducing new tax laws. As Winston Churchill very effectively said, "I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself by the handle." In other words, imposition of new taxes has to be extremely well rationalised.

According to the law of diminishing returns, the revenues generated by additional taxes will be less effective with every unit increase in taxation. It is therefore equally important for the government to consider incentives to promote priority areas.

While it is increasingly important for revenue to be raised, the government has introduced new amendments and taxation laws on the not for profit (NPO) sector as part of the Finance Bill 2017 -- 30 per cent corporate tax if administrative and management expenditure exceeds 15 per cent and an overall 10 per cent tax will be imposed on not for profits.

To top the imposed hardship and scrutiny, the Punjab government is pushing forward another legislation that will establish a regulatory body to act as a watchdog and regulate all nonprofit organisations from funding to their management. Comprising retired judges and civil servants, this commission would monitor and ensure proper utilisation of funds, perform periodic evaluations, hold audits, appoint trustees and hold enquiries. The existing laws on NPOs are already very stringent and their regulations include getting NOCs, certification from PCP, obtaining approval from FBR for tax exemption and much more.

There are still millions of individuals like Umme Laila and their families who are unable to improve their standard of living and live below poverty line because of a lack of financial resources. Their everyday lives are bogged down with struggles to put food on the table and most have no access to healthcare or education for their children. If these taxation laws are implemented, enhanced scrutiny will make it difficult for NPOs to operate and deliver results. Overloading organisations with increased auditing and book keeping will divert their focus from carrying out their core activities and prevent them from reaching out to poor communities that have not yet been touched. Further, raising international as well as local funding will become a challenge as donors will question the validity of donating to NPOs that are taxed by government.

It is no doubt important to effectively control misuse of funds and align political will with socio-economic progress but current proposals of striking impossible laws on charitable entities may pose more harm than good. Improving quality of life and social well-being of the nation’s poorest and striving for a developed economy is a common goal between the two sectors. This goal surely cannot be achieved if one sector chokes the other -- the current ruling party should reverse these laws in light of the negative effects these can have.

Taxation and the law of diminishing returns